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Sunday, June 21, 2009

The importance of roads in establishing a link between production site and market:

As recently as 5 years ago, farmers in Belanting had to pay Rp15,000 ($1.26) to take 100 kilos of rice to the market, a fee that significantly cut into their already narrow profit margins. Today, Mr. Maca says he only pays Rp1,000-less than 10% of what he previously did- and profits from his farm have more than doubled.

The banking sector is one of the few industries performing reasonably well most of the time. This has been one of the most attractive industries for employment and internship and investors, thanks to impressive performance of commercial banks and some development banks. However, there are some banks- whose balance sheet is weak; liabilities are in far excess of assets; who engage in risky deposit schemes with unreasonably high interest rate offers just to entice depositors; and engage in shady practices with backing from incompetent management and promoters- whose dismal performance is fueling anxiety among depositors and investors.

The failure of few of these banks to correctly assess their own capacity and ability to cater to the interests of depositors and investors has created an environment where the public is questioning soundness of the entire banking industry. This has impeded efforts to foster healthy competition, ensure market confidence, and promote a bankable banking industry where a run on one bank would not become a contagion and drag the whole industry down.

Nepal Development Bank (NDB) - which aspired to “enter the new millennium with profitability, size and efficiency on par with the best of the banks in the world”- is one of the zombie banks that have been a victim of its own irresponsible acts (recall the fate of Nepal Bangladesh Bank in 2006). The central bank has asked NDB management to furnish details on why it should not be liquidated. In any case, given the mess NDB is right now, it is in the interest of depositors, investors and the whole banking industry to liquidate NDB immediately.

According to media reports, the central bank estimated that NDB had bank deposits and cash worth Rs 196.20 million and its cumulative loss amounted to Rs 690.2 million (the bank management did not even know the full scale of its losses and claimed it amounted to Rs 640 million only). The non performing loans (NPL) comprised over 50 percent of its loan portfolio. The negative capital adequacy ratio of 48.31 percent was far less than 11 percent allowed by the central bank.

What is surprising is that even with dubious balance sheet and mounting losses, NDB management showed sheer irresponsibility by asking the NRB not to liquidate the bank. The irresponsible management team’s stubbornness is being amplified by lobby groups such as the Association of Nepali Development Banks (of which NDB is not even a member!) and the Association of Finance Companies. They have asked the central bank to revive the dead bank. For what? To vindicate NDB management of its reckless and stupid decision as if nothing wrong happened. The bank should have been liquidated back in 2004 and action taken against the then executive chairman and promoter Uttam Pun, who, unfortunately, went roundabout NRB’s weak regulatory power and used Appellate court, which itself is ineffectual in dealing with financial cases, to rescind the central bank’s action.

The central bank has rightly intervened and has also tried to calm down wary depositors and the market. Its plan to liquidate NDB to contain further losses and not let the bank operate with phony balance sheet that does not even satisfy minimum requirements, let alone prospect for profits, for sound banking practices is exactly what is needed at the moment. The NRB, despite regulatory and institutional weaknesses, has to show that it is tough and capable of reigning in banks that taint the image of the otherwise healthy banking industry. To avert the spread of contagion (of bank run) arising from the failure of NDB, NRB has also assured safety of deposits. This is required at the moment but should not be a permanent stamp due to fears of moral hazard. Now is the time to ponder upon establishing a national deposit insurer that would insure deposits up to a certain limit.

If the central bank does not liquidate banks like NDB, then the banking industry might engage in risky lending and unsustainable deposit schemes hoping that ultimately the government and NRB will bail them out in case of bankruptcy. The NRB needs to send a strong signal to the market that it is a responsible and strict watchdog of the banking industry. Veering away from this responsibility might foster unhealthy banking practices, where a single bank failure could pose a systemic risk to the whole banking industry. At the moment, the failure of NDB does not pose this kind of risk. However, failure to let it go would foster malpractices by unscrupulous board of directors, loss of taxpayer’s money and risk consumer’s deposits, leading to more sicker and zombie banks whose downfall might be contagious. Continued existence of banks like NDB would decrease the industry’s competitiveness, which is the last thing the economy needs at a time when successful international banks are preparing to enter the Nepali financial market in 2010 according to the WTO rules.

For now, the government and the central bank should fully liquidate NDB, take action against its management team and promoters, and send a signal to depositors that their deposits are safe and to the market that the central bank is vigilant and committed to fostering healthy competition in the banking industry.

About

Formerly, economics officer at Asian Development Bank, Nepal Resident Mission. Worked as a researcher at SAWTEE, Kathmandu. Also, worked as a consultant for Ministry of Commerce & Supplies, Government of Nepal; FAO; UNDP, GIZ-CIM, and ADB among others. I was an op-ed columnist for Republica between December 2008 – June 2012. I also worked as a Junior Fellow for Trade, Equity & Development program at Carnegie Endowment for International Peace, Washington, D.C .